Investopedia Advisor submits: It all sounded so great when it was announced last June. Three of the world’s mining giants, Phelps Dodge (PD), Inco (N) and Falconbridge (FALB), would combine in a three-way merger to create the world’s largest publicly traded copper and nickel producer.
Then, things started going wrong.
Despite lauding it as “industry redefining,” support for the deal quickly evaporated in the Falconbridge executive suite when Australian mining giant Xstrata plc stepped up to plate with a competing offer for Falconbridge that their shareholders found too good to refuse.
Lacking its critical third leg, the proposed combination quickly lost its strategic rationale. Sensing opportunity in the midst of the ensuing turmoil, Brazilian iron ore giant Companhia Vale do Rio Doce - CVRD (RIO) quickly entered the fray and trumped Phelps Dodge’s mostly share-exchange based bid for Inco with an all-cash offer of C$86 a share. Seeing nothing to be gained from engaging in a bidding war in a deal already gone partially sour, Phelps Dodge quickly announced that it would terminate its bid for Inco.
This disappointing news has so far been greeted with a measure of exuberance on the part of Phelps Dodge shareholders, who have bid up the shares by almost 4% since Tuesday’s Inco bid termination announcement. Do they have reason to be so positive?
For starters, Phelps Dodge will immediately receive a US $125 million deal-termination penalty payment from Inco, with another US $350 million potentially payable if Inco cuts a deal with another party by Thursday, September 7th. With the Brazilian bid still on the table, a quick closing and a further windfall payout to PD shareholders is still possible – but not likely.
Cancelling the deal also spares current Phelps Dodge shareholders from the massively dilutive effects that would have resulted had the three-way merger gone through. Up to 300 million new PD shares could have been issued, more than doubling the 204 million PD shares already outstanding. Moreover, the combined entity would have carried approximately US $22 billion in goodwill on its books – an intangible asset that has a dubious reputation in the eyes of many financial analysts.
For its own part, Inco has yet to give a favorable response to its Brazilian suitor, perhaps hoping that one more bidder may still be willing to enter the fray with a higher offer. One distant possibility is that earlier bidder Teck Cominco Ltd. (TCK) may yet come in with a sweetened offer after pulling out in mid-August.
So what are we to make of all of this?
It’s clear that one unintended consequence of the ambitious Phelps Dodge/Inco/Falconbridge merger plan has been to launch the industry equivalent of a global arms race. The bidding feeding frenzy that has ensued comes against a backdrop of sky-high base metals prices that have been pushed to record levels by seemingly insatiable demand from China and India. All the players in the game are betting that however much they overpay for producing assets right now, they will more than fully recoup the investment from future profits realized from the sale of metals production at ever higher prices.
My instincts tell me that the frantic nature of the current bidding activity has all the earmarks of the sort of peak cycle behavior that is typical for a highly cyclical business like mining. After several years of booming metals prices, the global players involved in this little drama have treasuries bulging with cash. It’s at times like these that the temptation to do the “big deal” exerts a powerful influence on the personalities involved. Sometimes boardroom egos can overarch sound business judgment in such circumstances.
With the Inco deal now dead, the rumor mill is churning out another scenario that could see the hunter become the hunted. Phelps Dodge itself is now seen as a takeover target with Southern Copper Corp (PCU) cited as a potential buyer. If a deal does materialize (and anything now looks possible in the current feeding frenzy atmosphere), I’d recommend that shareholders take the deal that offers cash over shares. I reckon that anyone who decided to take the money and head straight for the bank could revisit the sector some years hence and find a decidedly less exuberant set of circumstances and materially lower valuations.
PD 1-year chart:
By Eugene Bukoveczky, Contributor - Investopedia Advisor
At the time of release Eugene Bukoveczky did not own any shares in any of the companies mentioned in this article.